Retirement planning is an essential part of financial security. While traditional retirement accounts typically focus on stocks, bonds, and mutual funds, selfdirected retirement plans provide almost unlimited flexibility. A self-directed retirement plan allows account holders to invest in alternative assets, including real estate, real estate syndications, mortgage funds, and private loans.

Lending to and from a self-directed retirement plan, such as a Self-Directed IRA (“SD IRA”) or a Self-Directed 401(k) (“SD 401(k)”), can provide significant benefits, but it also comes with strict regulations and potential risks. This article explores how self-directed retirement plan lending works, the legal framework, advantages and drawbacks, and best practices for making loans.

Understanding Self-Directed Retirement Plans

Though there are numerous types of retirement plans available in the U.S., the most common are the Individual Retirement Account (IRA) and the 401(k). According to the Investment Company Institute (https://www.ici.org/401k), as of September 30, 2024, 401(k) plans held $8.9 trillion in assets, and IRA plans held $15.2 trillion. Both plans are designed to provide tax benefits and income at retirement, but there are two chief differences:

  1. IRAs are sponsored by the individual account holder. Anyone with earned income can contribute to an IRA. The IRA contribution limits for 2025 are $7,000 for those under age 50 and $8,000 for those age 50 or older. All funds in an IRA must be held and invested by an independent custodian, usually at the direction of the account holder. The custodian can be a bank, brokerage, trust company, or any other entity approved by the Internal Revenue Service to act as an IRA custodian. These companies limit the IRA account holder to only those investments that they offer – typically stocks, bonds, mutual funds, CDs, etc.Alternatively, many IRA holders choose to place their money with an independent Self-Directed IRA custodian that does not offer specific investments but will place the IRA holder’s funds into any permissible investment at the direction of the IRA holder. This could be a special-purpose LLC held by the custodian but run by the IRA holder, thereby enabling the holder the freedom to make permissible investments without the bureaucratic constraints imposed by the custodian. This is called “checkbook control.”
  2. 401(k) plans are company-sponsored, and it’s well known that many large companies offer these plans to their employees. Self-Directed 401(k) plans are a subset of these large plans and follow essentially identical investment rules. In this case, however, SD 401(k) plans are only available to self-employed individuals with no full-time employees aside from a spouse.For 2025, the maximum contribution limit for a self-directed 401(k) is age-dependent but ranges between $70,000 and $81,250 per person. Thus, a husband-and-wife team can contribute up to $162,500 to their plan. Clearly, for those who qualify, the financial advantages of an SD 401(k) plan over an SD IRA are huge.The other difference between an SD IRA and an SD 401(k) plan is that there is no requirement to use a custodian for an SD 401(k) plan. These are trusts, and the funds are typically held in a trust account at a bank, with the company owner as the trustee and in full control of the money (again, checkbook control). In this case, with no guidance from a custodian, the trustee must fully understand the rules behind all plan investments.

Retirement plan holders must be careful that they do not create a prohibited transaction. This could cause the plan to be disqualified, leading to potential taxes, penalties, and mandatory distributions. Fortunately, the rules are limited and allow for a wide variety of investments.

Permissible Investments

Almost any type of investment is permissible inside a self-directed retirement plan, with the exception of collectibles such as artwork, rugs, certain coins, alcohol, stamps, gems, and certain tangible property. The list is only slightly longer, but all business-purpose real estate, real estate notes and mortgages, syndicated funds, and private/hard money loans are permissible investments. Factoring and other business loans are also permissible. The key is that all funds that come from the plan, plus all profits, must be deposited back into the plan. That is, the retirement plan holder cannot personally profit from a retirement plan investment.

Disqualified Persons and Self-Dealing

The retirement plan account holder is a disqualified person and, as noted above, cannot personally profit from an investment made by their retirement plan. This is considered self-dealing. Nor can any of their lineal descendants – mother, father, grandmother, grandfather, son, daughter, grandkids, etc. – as well as their spouses. It is permissible for a retirement plan to do business with brothers, sisters, aunts, uncles, cousins, and their spouses. The list of prohibited parties also includes fiduciaries, other service providers, and companies in which the plan holder holds more than a 50% interest.

What Is a Special-Purpose LLC?

The LLC discussed herein is called “Special-Purpose” (“SP LLC”) because it references the permissible investments and disqualified persons defined above, as well as other restrictions, in its operating agreement. These prevent the account holder from entering into a deal that could cause the plan to be disqualified or penalized. The organizational documents needed for these investment vehicles are not standard. They should be obtained from an attorney specializing in retirement plan formation.

Lending with a Self-Directed Retirement Plan

The majority of CMA members are private/hard money lenders accustomed to originating loans using their own money, that of their fund, or on behalf of others. As we know, lending secured by California real estate – the focus here – requires a license from either the DRE or the DFPI. And there’s the rub: both SD IRAs and SD 401(k) plans are trusts, and neither the DRE nor the DFPI offers licenses to a trust.

Originating CFL Loans from a Self-Directed Retirement Plan

As noted above, one benefit to opening a special-purpose LLC within an IRA is that, after the custodian deposits your IRA funds into the SP LLC, you are in control of all investments, with no additional constraints from the custodian. The additional benefit is that this LLC can become licensed as a California Finance Lender (CFL). With checkbook control and an associated CFL license, you can lend from the IRA to any non-disqualified person or their entity.

Similarly, though no custodian is required for a self-directed 401(k) plan, and the plan owner already has checkbook control, nothing prevents the plan owner (you) from creating a special purpose LLC anyway, getting it licensed as a CFL through the DFPI, and investing the plan’s funds into the now-licensed Special-Purpose LLC. Here again, the plan owner can use the CFL license to make loans from their SD 401(k) with the SP LLC as the beneficiary.

Originating Brokered Loans from a Self-Directed Retirement Plan

While only an entity is eligible for a CFL license, individuals can obtain a broker license from the DRE and, therefore, originate loans for a retirement plan. There are a few considerations, however.

To properly originate a loan, a broker must be compensated. In this case, their fee (profit) must be paid by the retirement plan. This violates the restriction against self-dealing. That is, you can’t personally profit from any investment made by your retirement plan – even for $1. Thus, brokers cannot originate loans from their retirement plan (SDIRA or SD 401(k)) nor for any plan owned by a disqualified person, but they can originate loans for other retirement plans. The solution then, is to use an unrelated DRE licensed real estate broker to originate loans from your SD 401(k) plan.

Individuals may service loans funded by their own self-directed retirement plan. It is advisable, however, to limit such servicing to simply collecting the monthly payment and to seek qualified third-party sources for more complex loan servicing situations. It is also possible to violate the disqualified person and self-dealing prohibitions if a loan to a self-directed retirement plan is serviced through the retirement plan owner’s DRE-licensed servicing company. Consult with competent legal counsel before servicing loans funded by your own retirement plans.

Making a Loan to an SD IRA or SD 401(k) Plan

All experienced lenders will have well-established lending criteria they use to qualify borrowers and their properties. With little exception, these won’t change when making a loan to a retirement plan. Any CFL or DRE licensed real estate broker can make a real estate loan to a self-directed retirement plan owned by a non-disqualified person. The one caveat is that the lender cannot require a personal guarantee. With rare exception, the penalties against any individual, or entity, who guarantees the loan are onerous – up to 100% of the loan amount. For those with strict policies requiring personal guarantees, this might mean they cannot make the loan. Otherwise, those who are properly licensed can make a loan to a self-directed retirement plan.

Conclusion

Self-directed retirement plans offer tremendous investment flexibility, especially for those interested in private lending or alternative assets. However, this flexibility comes with a need for strict compliance – particularly in avoiding prohibited transactions, self-dealing, and regulatory violations. Ensuring correct licensing, using special-purpose LLCs when appropriate, and respecting the disqualified person rules are critical to avoiding penalties. Lenders and investors should fully understand the implications before engaging in lending to or from these plans and may benefit from legal or tax guidance to remain compliant while maximizing opportunity.

Jeff Smallowitz is the manager of Private Lending Direct, a California finance lender. He can be reached at jeff@privatelendingdirect.com.